Skidelsky on Keynes's "The Absolutists of [Debt] Contract[s]… Are the Real Parents of Revolution"

There are two possible reasons for the discrepancy between forecast and outcome. Either the damage caused by the financial crisis was more serious than people realized or the economic medicine prescribed was less efficacious than policymakers believed.

In fact, the gravity of the banking crisis was quickly grasped. Huge stimulus packages were implemented in 2008-09, led by the United States and China, coordinated by Britain, and with the reluctant support of Germany…. As a result, the slide was halted, and the rebound was faster than forecasters expected. But the stimulus measures transformed a banking crisis into a fiscal and sovereign-debt crisis. From 2010 onwards, governments started to raise taxes and cut spending in response to growing fears of sovereign default. At that point, the recovery went into reverse.

As Carmen Reinhart and Kenneth Rogoff tell it… there is no secure way of short-circuiting a deep banking crisis…. However, there is something missing in the [R&R] story. Recovery from the Great Depression took about 10 years, more than twice the post-war average…. [F]iscal policy and the monetary-policy regime have a decisive influence both on the depth of the collapse and how long before the economy recovers…. The major post-war crises that Reinhart and Rogoff consider run from 1977 to 2001. They occurred because regulation of banks and controls on capital movements were lifted; they were shorter than in the 1930’s because the policy responses were not idiotic….

Today, many governments, especially in the eurozone, seem to have run out of policy options. With fiscal austerity all the rage, they have given up ensuring that “people can buy” and “industries can produce.” Central banks have been handed the job of keeping economies afloat, but most of the money that they print remains stuck in the banking system…. Moreover, the eurozone itself is a mini-gold standard, with heavily indebted members unable to devalue their currencies, because they have no currencies to devalue….

With fiscal, monetary, and exchange-rate policies blocked, is there a way out of prolonged recession? John Geanakoplos of Yale University has been arguing for big debt write-offs…. Philosophically, the debt-forgiveness approach rests on the belief that creditors share culpability for defaults with debtors, since they made the bad loans….

In 1918, Keynes urged the cancelation of inter-Allied debts arising from World War I. “We shall never be able to move again, unless we can free our limbs from these paper shackles,” he wrote. And, in 1923, his call became a warning that today’s policymakers would do well to heed: “The absolutists of [debt] contract… are the real parents of revolution.”